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RRSPs


Legally accepted tax shelters do not reduce your tax burden. At the very most they can postpone the payment of taxes, but in most cases tax shelters increase the burden of taxes that one pays.

The most commonly known legally accepted tax shelter is likely the RRSP.

With the RRSP, one of the fallacies is that people believe that there is some sort of government department responsible for managing the money and keeping it safe, due to the fact that it is “registered”.

The reality is that everything is at risk, and there is no safeguards to ensure that the money remains payable to the participant.

Here is an example of how bad an RRSP can be, if we took somebody who was born in 1950, and starts working full time in 1970, and works the typical 45 years until age 65, they would reach retirement age in 2015.

If they start working in 1970, and decide that they are going to put 20% of their income into an RRSP (approximately $1000 in 1970 dollars) which may have generated a $100 refund at the time. Then when they go to withdraw the money in 2015, assuming that they earned only the inflation rate each year (a real return of 0%) they will have to withdraw $7000 in 2011 and have to pay tax of $1400. So essentially they have been taxed 140% on their initial investment.

The biggest problem with RRSPs is the unavailability of the money. The money is tied up in the RRSP, and cannot be used, whereas if the money is free from the RRSP, it is working capital, that can be invested in whatever one see fit, or it can be used to pay down a mortgage or other debt. Therefore having the money tied up in an RRSP comes at a huge opportunity cost.

The second biggest problem with an RRSP is that once a person reaches age 65, any funds that they withdraw from the RRSP is added to their income. This makes it so that their income is so high that it could result in a claw back of up to 100% of their Old Age Security payments, and any other low income tax credits that they otherwise would have received.

If someone has an emergency situation, such as a job loss, where they need to access the RRSP, not only will they have to pay a minimum withholding tax of 10%, but they will also have to refund the government any E.I. premiums, and/or other social assistance payments that they receive during the period of unemployment. Not only are they out the withholding tax, they are out all of the other money they received during the rough patch. In addition, whatever they withdrew will be added to their income which is certain to result in an additional tax liability at the end of the year.

Furthermore, if the participant dies before they are able to withdraw and pay tax on all of their funds, the total value of the RRSP at time of death is added into the beneficiary’s income and fully taxable in their hands in the year of death.

As far as voluntary acts go, contributing to an RRSP is probably the worst voluntary act that a person can possibly do. It is complete voluntary financial self-destruction, and a way to punish oneself heavily.

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